The balance sheet at Wynn Resorts (WYNN) is so terrible that, as a threshold matter, it precludes me from ever considering an investment in this casino stock.
Last August, Wynn Resorts opened its $4 billion ode to excess in Macau. The expenses were obscene, with the lake alone costing over $100 million. The best-case analyst scenario calls for this resort to contribute $210 million in annual profits to the bottom-line for Wynn shareholders. The pessimistic forecasts are not even sure that this resort will be profitable over the long term.
The problem is that the Macau Wynn Resort has been funded entirely with debt. This radically altered Wynn stock’s risk profile for the worse.
In its early days, Wynn Resorts used leverage responsibly. From its IPO until the Macau project, Wynn’s balance sheet was never leveraged more than ten to one. Even as recently as five years ago, Wynn Resorts was only carrying $3 billion in debt while it was making $700 million in profits. The profits were only leveraged four-fold. For a casino and resort operator, that was an excellent balance sheet.
Now, Wynn has taken advantage of low interest rates to raise is debt burden to $10 billion. Meanwhile, the unmet expectations at Macau and dampening interest in casino gaming and golfing at its Las Vegas locations have driven Wynn’s profits down to the $300 million level.
As a result, Wynn now reports a nonsensical leverage ratio of 33:1. That is crazy. That is un-responsible. That is such a terrible debt to profit ratio that I can’t even consider the stock as anything other than speculation because it is one recession away from massive share dilution or even bankruptcy.
Since 2002, Wynn has reported negative earnings for three calendar year. What happens if a nasty recession strikes and Wynn is unprofitable while chunks of the $10 billion principal come due? It is already on the hook for half a billion in interest payments over the next seven years–what happens if it has to refinance at rates that reflect a higher interest rate environment and the heightened risk that being a bondholder of Wynn now poses?
I was reading a research report on Wynn produced by the Telsey Advisory Group, and I couldn’t help but notice the over-reliance on EBITDA on discussing the rationale for owning Wynn stock. A good signal that a large-cap stock is trouble is if no one is talking about net profits and instead have to rely on some other metric to justify the investment. There are exceptions, but Wynn isn’t it. Heck, it should be thriving now while the global economy is seven years into steadily advancing economic conditions. If profits have fallen in half over the past five years while the economy improves, what happens to Wynn if we encounter a recession?
The upside for Wynn shareholders is that Wynn has $2 billion in cash. The downside is that the money is going to be deployed towards the overhaul of the golf course at the Wynn-Encore in Las Vegas and replaced with a “Paradise Park” that includes a water lagoon and 1,500 room hotel. At best, this will improve Wynn’s annual profits to the $500-$600 million range while it stews in $10 billion in debt. We are still talking about a leverage ratio in the 20:1 range when this project is completed.
I don’t know you could place a dollar value on the intrinsic value of this stock. There are too many contingencies, and too many lofty speculations, to get a grip on what the real earnings power will be. And when there is $10 billion in debt, you need to be certain about what the lower bounds of the cash flow might look like so you can determine whether the debt can be serviced. Personally, I read through the financial statements and I can’t find that clarity. I don’t know how some of these people put a sizable portion of their net worth into stocks like Wynn and sleep well at night. There are so many realistic worst-case scenarios you can draw up in which the capital of Wynn’s shareholders gets destroyed. You need everything to go well just to eke out average returns. It’s anti-margin of safety investing.
Originally posted 2016-11-30 16:30:00.